November 4, 2011 / 4:06 PM / 6 years ago

UPDATE 9-PepsiCo sells China bottling assets to Tingyi

* PepsiCo sells China bottling assets to Tingyi-Asahi

* Pepsi gets 5 pct of Tingyi-Asahi, option for up to 20pct

* Gives Pepsi products access to Tingyi distribution

* PepsiCo shares close down 1.3 pct

By Rachel Lee and Martinne Geller

HONG KONG/NEW YORK, Nov 4 (Reuters) - PepsiCo Inc agreed to sell its interest in 24 soft drink bottlers in China to Hong Kong-listed Tingyi Holdings Corp , an acknowledgment that its strategy in China was not working.

PepsiCo will initially receive only 5 percent of Tingyi-Asahi Beverages (TAB), Tingyi's joint venture with Japan's Asahi Group Holdings Ltd , a stake the companies valued at about $55 million. PepsiCo has the option of increasing its stake to 20 percent by 2015, when China is projected to become the world's largest market for bottled drinks.

PepsiCo's bottling business in China, which has a book value of $600 million, has lost money for the past two years amid soaring raw material costs and intense competition from Coca-Cola Co , whose share of the Chinese market is more than triple that of Pepsi.

Coca-Cola's sales volume rose 11 percent in China in the most recent quarter, fueled by its Minute Maid Pulpy, a drink Coke developed specifically for China that recently crossed the $1 billion sales threshold.

"Obviously, Coke is winning," said Michael Yoshikami, CEO of YCMNET Advisors. "When you're in China, Coke is very, very dominant."

He said Pepsi likely realized the boost its brands would get from linking up with Tingyi was a better way forward than "slugging it out with Coke."

"Is this a sign that Pepsi is retreating; that they can't contend with Coke one-on-one in a face-off to take over the biggest market in the world? Well, it sure looks that way," said Bevmark Consulting CEO Tom Pirko.

Analysts said the deal was good for Tingyi, since it lets the maker of Master Kong instant noodles and bottled tea expand its beverage offerings without hurting its balance sheet.

They also said it was good for PepsiCo, since it broadens its distribution, allows it to unload those loss-making operations and gives it a stake in a company poised for faster growth than Pepsi alone.

A combined Pepsi and Tingyi would control about 20 percent of the Chinese soft drink market, according to data from Euromonitor International, overtaking Coke, which has market share of nearly 17 percent. PepsiCo is currently fourth with a 5.5 percent stake.

"But (it) could also be viewed as a capitulation, as PepsiCo is surrendering some of the upside in one of its key growth markets and admitting the need for a partner," Levy said.

She also noted the similar arrangement PepsiCo has in Japan with Suntory Holdings Ltdhas not resulted in significant market share in that market.

CAPITULATION

China's massive billion-plus population has long been enticing to foreign brands, keeping most of the focus on inward investment from overseas.

The Pepsi/Tingyi tie-up marks a rare case in the consumer sector of a Chinese company acquiring a foreign stake within its own borders and not the other way around, as brands seek to seize market share and tap China's growing middle class, widening tastes and purchasing power.

Lois Olson, a marketing professor at San Diego State University who specializes in China, said the deal could be seen as evidence of the growing power of Chinese companies.

"There is an increasing power, leverage and sheer might in Chinese companies. They're getting a lot better at what they do," she said.

Still, she added the move probably had more to do with Coke than China.

"There aren't a lot of duopolies in the world and this is a huge, powerful duopoly. Coke really does dominate there," she said, noting the huge success in China of Yum Brands Inc , which runs the KFC and Pizza Hut chains and used to be part of PepsiCo, has not translated into success for PepsiCo.

Attempts by overseas businesses to enter China have not always been successful. Coca-Cola was blocked by regulators in its $2.4 billion bid in 2009 for Huiyuan Juice, which raised concerns among investors that such deals were effectively off the table.

Nestle, though, is currently eyeing a possible $2.6 billion deal to buy candy maker Hsu Fu Chi International Ltd . And Diageo, the world's largest spirits group, took a major step forward in June toward taking control of Sichuan Shuijingfang Co Ltd , China's fourth-largest white spirits group.

Under the alliance, TAB would work with PepsiCo's current bottlers to manufacture and distribute PepsiCo's drinks, while PepsiCo would keep responsibility for branding and marketing. TAB would begin co-branding its juice products under the Tropicana brand name.

The deal is subject to review and approval under China's Anti-Monopoly Law and approval of Tingyi shareholders.

A PepsiCo spokesman said the company would begin seeking those approvals immediately and said it would be inappropriate to speculate on how long the process would take.

Tingyi, which owns the Master Kong brand of instant noodles, drinks and snacks, has a market capitalization of $15 billion after a roughly 20-fold increase in its share price in the past 10 years on rising consumer demand in China.

PepsiCo said last year it would invest $2.5 billion in its food-and-beverage businesses in China over the next three years. It had said it planned to open 10-12 new plants in China to manufacture soft drinks, noncarbonated beverages and snacks and would install additional production lines at existing facilities.

UBS advised PepsiCo on the deal, while J.P. Morgan advised Tingyi.

PepsiCo shares closed down 1.3 percent at $61.99 on the New York Stock Exchange on Friday.

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